Having nonprofit does not make you tax exempt entity

A Colorado nonprofit can be set up online with the Colorado Secretary of State. However, setting up a nonprofit with the Colorado Secretary of State does not make you a tax-exempt entity, nor does it mean that contributions to your organization will be tax deductible to the donors.

To be a tax-exempt organization, you must apply to the IRS using Form 1023 for 501(c)(3) status (23 pages) or Form 1024 for other tax-exempt organizations (19 pages). But, before you travel down the road of becoming a 501(c)(3), make sure your organization asks these two questions:

Will your nonprofit bring in enough taxable income to make avoiding taxes a concern? If your organization does not bring in any income from business activities, it won’t owe any taxes. But, if you plan to have business activity that is related to your mission (fees from clients receiving your services for instance), then being tax-exempt will save you money.

Do you need to be eligible for grants or to attract large contributions? Many organizations do just fine with small contributions. Your nonprofit may only need to raise money from people who don’t care about deducting their donations for tax purposes. In that case, you don’t need to pursue 501(c)(3) status.

If you are a 501(c)(3), you must understand unrelated business income tax (UBIT). If you are conducting a business or trade that is not related to your tax-exempt purpose, the unrelated business net income is subject to tax. The tax rates are the same as for corporations. In a perfect world, nonprofits should steer clear of UBIT.

On to more traditional funding, donor contributions and a nonprofit’s responsibility for reporting has many levels. Donor-designated payments, as long as the nonprofits have full control of the donated money and discretion to their use, are tax exempt.

A caution, money paid to attend events or to purchase an item at the silent auction is assumed to have a value (quid pro quo). If your donors want to receive a tax deduction, your receipt must say what portion were for goods received and what portion was the donation for the organization.

Substantiation rules state that a written receipt must be issued for donations of $250 or more in a calendar year. Also, a nonprofit furnishing goods or services in return for a donation of more than $75 must provide a letter stating the deductible portion of the donor’s payment.

There are three resources that will help staff members work through this process. They are IRS publications 1771 and 561 as well as stayexempt.org.

Because nonprofit staff is stretched thin, it is important donors understand what donations are tax deductible also. This is a list of contributions that are not deductible:

Contributions to a specific individual.

Contributions to a nonqualified organization.

The part of the contribution from which you receive or expect to receive benefit.

The value of your time and services.

Your personal meals or living expenses, unless incurred in overnight services for the organization.

Appraisal fees.

Certain contributions of partial interests in property; for example, use of your property.

For the last bullet, certain contributions of partial interests in property, can be researched in IRS Publication 526. It is a helpful publication that gives several real world examples.

Bottom line: IRC 501(c)(3) has a lot of rules and regulations to stay in compliance with the IRS. It is important for staff members and donors to understand their options. The Community Foundation continues to be a resource for the nonprofit sector. In fact, the information in this article has been distilled from a nonprofit workshop put on by FredrickZink & Associates and the Community Foundation serving Southwest Colorado.